UNITED STATES OF AMERICA
Before the
SECURITIES AND EXCHANGE COMMISSION
SECURITIES EXCHANGE ACT OF 1934
Release No. 38876 / July 28, 1997
ACCOUNTING AND AUDITING ENFORCEMENT
Release No. 941 / July 28, 1997
ADMINISTRATIVE PROCEEDING
File No. 3-9247
ORDER SETTLING CEASE-AND-
DESIST PROCEEDINGS, MAKING
In the Matter of:
FINDINGS AND IMPOSING A
CEASE-AND-DESIST ORDER
WILLIAM D. KYLE,
Respondent.
I.
The Securities and Exchange Commission ("Commission") has previously
instituted cease-and-desist proceedings pursuant to Section 21C of the
Securities Exchange Act of 1934 ("Exchange Act") against William D. Kyle
("Kyle" or "Respondent"). Kyle subsequently has submitted an
Offer of Settlement ("Offer"), which the Commission has determined to
accept.
II.
Solely for the purpose of this proceeding and any other proceedings
brought by or on behalf of the Commission or in which the Commission is a
party, and without admitting or denying the findings contained herein,
except that Respondent admits the jurisdiction of the Commission over him
and over the subject matter of this proceeding, Respondent consents to the
issuance of this Order Settling Cease-and-Desist Proceedings, Making
Findings and Imposing a Cease-and-Desist Order ("Order") and to the entry
of the findings and the imposition of the relief set forth below.
The Commission instituted the cease-and-desist
proceeding on February 18, 1997. See Securities
Exchange Act Release No. 38297.
III.
On the basis of this Order and Respondent's Offer, the Commission
finds the following:
A. RESPONDENT
Respondent Kyle was, from May 1993 to January 1996, National Sales
Manager of Midisoft Corporation ("Midisoft" or "the Company").
B. ENTITY INVOLVED
Midisoft, founded in 1986, is a Washington State corporation with its
principal place of business in Issaquah, Washington. Midisoft develops and
markets interactive, audio-based software applications for the Microsoft
Windows and multimedia applications market, including software that allows
users to produce and manipulate music on a personal computer. The
Company's common stock has been registered with the Commission pursuant to
Section 12(g) of the Exchange Act since July 1993 and is quoted on The
NASDAQ Stock Market. For the most recent fiscal year, ended December 31,
1996, the Company posted revenues of $3,113,000, a net loss of $5,716,000
and a net loss per share of $1.22. As of March 10, 1997, with 5,624,951
shares outstanding and a closing price per share of $1.88, Midisoft had an
aggregate market value of $10,574,907.
C. FACTS
1. Midisoft's Internal Accounting Policies and Practices Regarding
Purchase Orders.
At all relevant times, Midisoft's internal accounting policy, as set
forth in the Company's 1994 Form 10-K, stated that the Company recognized
revenues on sales to distributors, resellers and other end-users only when
products were shipped to those customers.
During the fiscal year ended December 31, 1994, the process of
shipping goods to a distributor typically began with the receipt by
Midisoft of a written purchase order from the customer. The sales
administrator for distributor sales (the "Sales Administrator"), who
reported directly to Kyle, would then enter the purchase order into
Midisoft's computer accounting system, known as Macola.
The information the Sales Administrator input into the Macola system
was used by Midisoft's Shipping Department to determine what orders to fill
and ship. The Shipping Department typically filled and shipped orders
input into the Macola system as soon as possible in the normal course of
business. Then, once the Shipping Department obtained documentation
The findings herein are made pursuant to Respondent's
Offer and are not binding on any other person or entity
in this or any other proceeding.
======END OF PAGE 2======
showing that the goods had been shipped, Midisoft's Accounting Department
could book the revenues associated with the shipment, in accordance with
the Company's stated policy.
On occasion, some Midisoft customers would place orders which they did
not want to have delivered in the normal course of business, but rather
desired to have delivered at some later date, or upon later instructions.
In these instances, it was the practice of the Sales Administrator to input
the purchase order into the Macola system with a special notation that the
order was to be filled at a specific later date, or upon the receipt of
further instructions.
2. Conduct Leading to Midisoft's Materially Misleading Form 10-K for
Fiscal 1994.
In December 1994, at the direction of certain Midisoft officers, Kyle
and another Midisoft salesperson who reported directly to Kyle obtained
written purchase orders from two of Midisoft's distributor customers (the
"Contingent Purchase Orders"). Kyle knew that the distributors had agreed
to provide the Contingent Purchase Orders to Midisoft based on the
understanding that Midisoft would not ship goods relating to these orders
in the normal course of business. Rather, as Kyle was aware, these
distributors expected Midisoft to delay shipping some or all of the goods
relating to the Contingent Purchase Orders until such time as the
distributors provided Midisoft with further instructions.
Kyle directed the Sales Administrator to enter the Contingent Purchase
Orders into the Macola system. At the time, Kyle was aware of the
contingent nature of these orders, and was aware that the orders themselves
did not contain any notation as to a delay in shipping. Nevertheless, Kyle
did not instruct the Sales Administrator to include in the Macola system
any notation regarding a delay in shipping.
Because Midisoft did not expect to ship goods relating to the
Contingent Purchase Orders in the normal course of business, Midisoft could
not have expected to recognize revenues on these orders during fiscal 1994.
To address this problem, certain Midisoft officers directed Kyle to go back
to his customers and obtain written confirmations that the customers would
take title to the goods relating to the Contingent Purchase Orders during
fiscal 1994 at a Midisoft warehouse. In this way, Midisoft hoped to
recognize revenues on the Contingent Purchase Orders during
======END OF PAGE 3======
fiscal 1994, without actually shipping the goods to its customers during
that year.
Kyle attempted but was unable to obtain any such written confirmations
and he informed at least one Midisoft officer of this fact in December
1994. Despite this, at no time did Kyle direct his Sales Administrator to
cancel the Contingent Purchase Orders from the Macola system, nor did he
instruct the Sales Administrator to include in the Macola system any
notation regarding a delay in shipping these orders.
In a meeting in late December 1994 certain Midisoft officers and
employees discussed the fact that, despite Kyle's inability to obtain
agreements from his customers regarding taking title to the goods at a
Midisoft warehouse, Midisoft would recognize revenues relating to the
Contingent Purchase Orders in fiscal 1994. Midisoft carried out
this plan, in part, by storing the goods at a freight forwarding company
and obtaining phony documents from the freight forwarder to indicate that
the goods had been shipped on or prior to December 31, 1994.
From January through March of 1995, Midisoft had to manage the stock
of goods stored at the freight forwarder relating to the Contingent
Purchase Orders. To do this, the Sales Administrator prepared a computer
worksheet that showed each of the Contingent Purchase Orders, the amount
(if any) of goods relating to that order that Midisoft actually shipped on
or prior to December 31, 1994, the amount of each subsequent shipment
against that order, and the amount of goods still remaining at the freight
forwarder.
From time to time during the first three months of 1995, the Sales
Administrator provided a copy of this worksheet to Kyle. During that time,
Kyle periodically instructed the Sales Administrator to release certain
goods held at the freight forwarder for delivery to Midisoft's customers.
The worksheet prepared by the Sales Administrator was not integrated
into Midisoft's established internal accounting system. As a result,
Midisoft was able to manage the goods stored at the freight forwarder
without alerting the Company's outside auditors, who were then auditing
Midisoft's 1994 fiscal results. Moreover, Kyle was aware during this
period that the purpose of storing the goods at the freight forwarder was
to allow Midisoft to recognize revenues on those goods during fiscal 1994,
prior to the time they were actually shipped to Midisoft customers. In
late March 1995, just prior to the end of the first quarter of Midisoft's
1995 fiscal year, Midisoft arranged to receive back from the freight
forwarder all the remaining goods relating to the Contingent Purchase
Orders.
On or about April 14, 1995, Midisoft filed its original Form 10-K with
the Commission for the fiscal year ended December 31, 1994. When compared
with the Company's Amended Form 10-K for fiscal 1994, which Midisoft filed
on or about August 8, 1995, the original Form 10-K overstated the Company's
Kyle did not attend this late December 1994 meeting.
======END OF PAGE 4======
revenues for fiscal 1994 by a total of $811,000, all of which occurred in
the fourth quarter. Of this total, approximately $292,000 was the result
of the recognition of revenue on the Contingent Purchase Orders for the
goods that Midisoft did not ship to customers during fiscal 1994. Without
the overstated revenues, Midisoft would have reported revenues for fiscal
1994 and for the fourth quarter of the year of $4,989,000 and $685,297,
respectively.
D. LEGAL ANALYSIS
1. Kyle Caused Midisoft to Violate Provisions Governing Issuer
Reporting, Books And Records and Internal Accounting
Controls.
Pursuant to Section 21C of the Exchange Act, a person is a cause of a
violation of the provisions of the Exchange Act if the violation occurs
because of an act or omission which the person knew or should have known
would contribute to such violation. For the reasons set forth below, Kyle
caused Midisoft to violate Section 13(a), 13(b)(2)(A) and 13(b)(2)(B) of
the Exchange Act and Rules 12b-20 and 13a-1 thereunder.
a. Issuer Reporting Provisions: Section 13(a) and Rules 12b-20
and 13a-1
Section 13(a) of the Exchange Act and Rule 13a-1 thereunder require
that issuers whose securities are registered with the Commission pursuant
to Section 12 of the Exchange Act file with the Commission accurate annual
reports. Exchange Act Rule 12b-20 requires that such reports contain any
additional information necessary to ensure that the required statements in
the reports are not, under the circumstances, materially misleading. Thus,
the filing of a periodic report that contains materially false and
misleading statements or omissions constitutes a violation of the reporting
provisions of the Exchange Act. Violations of the reporting provisions do
not require a showing of scienter. SEC v. Savoy Industries, Inc., 587 F.2d
1149, 1166-67 (D.C. Cir. 1978), cert. denied, 440 U.S. 913 (1979).
Financial statements incorporated in Commission filings must comply
with Regulation S-X, which in turn requires conformity with Generally
Accepted Accounting Principles ("GAAP"). Statement of Financial Accounting
Concepts No. 5 ("CON5"), entitled "Recognition and Measurement in Financial
Statements of Business Enterprises," states that revenue should be
recognized when it is both realized (or realizable) and earned. Paragraph
83 of CON5 states that revenue is realizable when a product is "exchanged
for cash or claims to cash" and revenue is earned "when the entity has
substantially accomplished what it must do to be entitled to the benefits
represented by the revenues." In addition, Midisoft's own revenue
recognition policy, as set forth in its original 1994 Form 10-K, required
that it recognize revenue only after it shipped products to its customers.
By including in its original Form 10-K for 1994 $292,000 in revenues
relating to the Contingent Purchase Orders, Midisoft overstated both its
fiscal year revenues and its revenues for the fourth quarter by 5.8% and
42.6% respectively, as compared with the Company's amended Form 10-K for
======END OF PAGE 5======
1994. This misstatement was material. See Basic v. Levinson, 485 U.S.
224, 231-32 (1988) (fact is material if there is substantial likelihood
reasonable investor would consider it important in making investment
decision); see also In re Gupta Corporation Securities Litigation, 900 F.
Supp. 1217, 1231 (N.D. Cal. 1994) (materiality of overstatement of revenues
greater than 5% "is beyond question"). As a result, Midisoft violated
Section 13(a) and Rules 12b-20 and 13a-1.
Moreover, Kyle knew or should have known that the following of his
actions or omissions would contribute to Midisoft issuing the materially
misleading Form 10-K for fiscal 1994: (1) failing to instruct the Sales
Administrator to include in the Macola System a notation of the fact that
Midisoft had agreed that it would not deliver goods relating to the
Contingent Purchase Orders unless and until it received further
instructions from its customers, even after the customers had refused to
take delivery of the goods at a Midisoft warehouse; and (2) instructing the
Sales Administrator during the first three months of 1995 to make shipments
out of the stock of goods held at the freight forwarder, even though Kyle
then knew that Midisoft intended to recognize these goods as revenues
during fiscal 1994 and that the Company was specifically storing the goods
at the freight forwarder to carry out its scheme. Accordingly, Kyle was a
cause of Midisoft's violations of Section 13(a) of the Exchange Act and
Rules 12b-20 and 13(a) thereunder.
b. Books and Records and Internal Accounting Controls: Section
13(b)(2)(A) and 13(b)(2)(B)
Section 13(b)(2)(A) requires that each issuer of securities registered
pursuant to Section 12 of the Exchange Act make and keep books, records and
accounts that accurately and fairly reflect the dispositions of its assets.
Section 13(b)(2)(B) requires that each such issuer also devise and maintain
a system of sufficient internal accounting controls.
By failing to instruct the Sales Administrator to enter the Contingent
Purchase Orders correctly in Midisoft's computer accounting system even
after the distributors had refused to take delivery at a Midisoft
warehouse, and by later directing the shipment of goods stored at the
freight forwarder relating to the Contingent Purchase Orders, Kyle was a
cause of Midisoft's failure to keep books, records and accounts that
accurately reflected the disposition of the goods covered by those purchase
orders, in violation of Section 13(b)(2)(A). In addition, Kyle's conduct
was a cause of Midisoft's failure to maintain a system of sufficient
internal accounting controls, in violation of Section 13(b)(2)(B).
2. Kyle Also Violated Certain Books and Records and Internal
Accounting Controls Provisions.
Section 13(b)(5) of the Exchange Act prohibits any person from
knowingly circumventing or knowingly failing to implement a system of
internal accounting controls or knowingly falsifying any book, record or
account. Rule 13b2-1 thereunder similarly prohibits any person, whether
indirectly or directly from falsifying or causing to be falsified any book,
record or account.
======END OF PAGE 6======
Kyle violated Section 13(b)(5) and Rule 13b2-1 when he failed to
instruct the Sales Administrator to enter the Contingent Purchase Orders
correctly in Midisoft's computer accounting system even after the
distributors had refused to take delivery at a Midisoft warehouse. In
addition, Kyle further knowingly circumvented Midisoft's internal
accounting controls when he instructed the Sales Administrator to ship
goods stored at the freight forwarder relating to the Contingent Purchase
Orders, even though he knew that such shipments were not properly reflected
in Midisoft's books and records.
3. Kyle Was Also a Cause of Midisoft's Violation of Section 10(b)
and Rule 10b-5 Thereunder.
Section 10(b) of the Exchange Act and Rule 10b-5 thereunder prohibit
material misstatements or omissions made with scienter in connection with
the purchase or sale of securities. SEC v. Texas Gulf Sulphur Co., 401
F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). The Ninth
Circuit has held expressly that a mental state of recklessness is
sufficient to satisfy the scienter requirement. Hollinger v. Titan Capital
Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990) (en banc) (as amended), cert.
denied, 449 U.S. 976 (1991).
Where the fraud alleged involves public dissemination in an annual
report or other such document on which an investor would presumable rely,
the "in connection with" requirement is generally met by proof of the means
of dissemination and the materiality of the misstatement. SEC v. Rana
Research, Inc., 8 F.3d 1358, 1362 (9th Cir. 1993) (issuance of press
release coupled with public trading in stock met requirement); Savoy
Industries, 587 F.2d at 1171 (filing of Schedule 13D coupled with public
trading in stock satisfies requirement).
Midisoft's original 1994 Form 10-K was materially false and misleading
because it contained the $292,000 in revenues relating to the Contingent
Purchase Orders for goods that were not shipped during fiscal 1994. Kyle
knew of or recklessly disregarded the fact that his actions as described
above would contribute to the issuance of this materially false report.
Accordingly, Kyle was a cause of Midisoft's violation of Section 10(b) and
Rule 10b-5 thereunder.
IV.
Based on the foregoing, the Commission finds that Kyle:
1. committed violations of Section 13(b)(5) of the Exchange
Act, and Rule 13b2-1 thereunder; and
2. was a cause of the violations of Sections 10(b), 13(a),
13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 10b-5, 12b-20
and 13a-1 thereunder.
V.
Accordingly, IT IS HEREBY ORDERED, pursuant to Section 21C of the
Exchange Act, that Kyle cease and desist from:
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1. committing or causing any violation and any future violation
of Sections 10(b) and 13(b)(5) of the Exchange Act, and Rules 10b-5 and
13b2-1 thereunder; and
2. causing any violation and any future violation of Sections
13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act, and Rules 12b-20
and 13a-1 thereunder.
By the Commission.
Jonathan G. Katz
Secretary
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